Back to Kondratieff

Some people are now revisiting Kondratieff''s theory of economic cycles. Seems to fit winter, at the moment. The above image is modified from this source: smart fellows.

A question

What would have happened if the UK had not followed suit with monetary inflation over the past 5 or 6 years?

Would prudence have been rewarded, or would a Protestant adherence to the right course of action have been punished by falling exports and unemployment? In a global trading system, when one major player makes a mess of their money, must others do the same or be sorry?

Can the world be run on the principles of the efficient-market purists, or is there an advantage to the first to break ranks? Are monetarists doomed to merely understand what is going on, incapable of preventing it?

Hope

Brad Setser sees hope in the correction:

I increasingly suspect that one consequence of United States and Europe’s recent financial crisis will be a smaller deficit in both regions, and a smaller surplus in the emerging world.

Robert McHugh was right!

15 months ago, Robert McHugh predicted this:

[The Dow] can be expected to drop to about the start of the pattern, at a minimum, meaning into the 9,000s over the intermediate-term... It is looking increasing likely to us that world central banks will choose hyperinflation rather than nominal decline in stock indices, which will force precious metals prices to rise sharply.

In gold-price terms, McHugh's Dow prediction came true on January 22 this year. Now it's come true in nominal terms, too (9,153.22 at 13:04 ET today) (UPDATE: 8.731.87 at 15:41).

It seems McHugh is an adherent of the Elliot Wave principle. Wikipedia gives a criticism of the theory:

The premise that markets unfold in recognizable patterns contradicts the efficient market hypothesis, which says that prices cannot be predicted from market data such as moving averages and volume. By this reasoning, if successful market forecasts were possible, investors would buy (or sell) when the method predicted a price increase (or decrease), to the point that prices would rise (or fall) immediately, thus destroying the profitability and predictive power of the method. In efficient markets, knowledge of the Elliott wave principle among investors would lead to the disappearance of the very patterns they tried to anticipate, rendering the method, and all forms of technical analysis, useless.

I think one could riposte that events have demonstrated that the efficient market does not exist.

A big figure

Hard on the heels of the $700 billion US bailout bill comes the UK's £400 billion rescue plan.

Oddly, this latter figure, in dollar terms, is very similar to the one approved by Congress - a little over $692 billion at today's retail conversion rates (and even closer in wholesale terms).

But the really interesting thing is the difference is in its relationship to the size of the population of the country, and the GDP:

Marc Faber recently said that the US needed $5 trillion to resolve the crisis, i.e. 7 times more than the amount approved by Congress. Britain's bailout fund is proportionately 7 times greater, and so, crippling cost to the taxpayer aside, maybe it could work.

And it has political implications. The average Brit is so innumerate that he doesn't know how to calculate 75% of 100, so don't expect him to understand that it wasn't simply "the banks" to blame, but the relaxation of Government monetary controls. Don't discount the possibility that, however undeservedly, Gordon Brown may win the next election.

End of the dollar as the world's reserve currency?

See the comment in Brad Setser's blog - Brazil and Argentina are already finding other ways to pay each other, Russia may deal in euros... if no-one wants the dollar after Jesse's predicted devaluation, it may go from devalued to almost worthless.

But what will countries do, that export to the USA? Devalue their own currencies? Or demand payment in euros? Or oil contracts? Even Setser admits to struggling to understand what's going on.

Jesse also comments on a report that the Gulf States may diversify into gold.

Dow: 6th anniversary of its 2002 low

Currency devaluation time?

Jesse reckons there's going to be a massive (30 - 40%) devaluation of the US dollar, in order to swindle foreign creditors.

Are there any currency experts out there who can tell me whether the UK won't race to do the same? Will the Yen and the Renminbi be forced upwards, relatively speaking? Should we be buying dried food etc instead of holding cash?

FTSE prediction: poll results

Thanks to all those who took part in the poll for the forecast value of the FTSE by the end of December. The median line is on 4,500.

This is what I guessed in June and repeated on Monday. Below that at the moment, but I'm still hoping that it'll settle back to the simplified trend I suggested. I prefer to be a sun bear, not a grizzly.

Are we there yet, Dad?

Stop blaming the Americans

The political formula here in the UK is "We'll do anything that's necessary" and "the sub-prime problem started in the USA." Misleading nonsense.

The Americans may have sold packaged mortgages, but our institutions here didn't have to buy stuff they didn't have the competence to analyze.

And we didn't have to have 6x earnings, LTV100%+, self-certification or a rush into buy-to-let.

This disaster is home-grown.

Crisis

Karl Denninger is sounding absolutely dire warnings about the market (Dow 4,000) and the economy; recently Jim from San Marcos said Dow 2,000 (and I do so hope he's completely wrong). This getting well into the worst fantasies of the Cassandras and we must hope that our apparently ignorant political class wises up fast.

Just a thought...

Who would now take financial advice from bancassurers?

Gold set to leap?

Jesse repeats the theory that the gold price is being held down at a time when we would expect it to soar. Presumably the stratagems will fail at some point. (Update: he's now tipping a spike, maybe doubling the current price.)

But as I said to clients long ago, whatever you treat as an investment will behave like one. We did it to houses, and see the result now; so investing in gold in the hope that you'll be able to sell on the spike, is a risky strategy. Buying in at a reasonable price, hoping simply to preserve your wealth; that's a different story.

CLARIFICATION

As I said quite a while ago, if you try to draw a line to get a notion of an "average" gold price, adjusted for inflation, where would you draw it? The current price, if you look at the graph above, would already seem to be above the median, presumably factoring-in concerns about the economy and currencies. My best guess, the last time, was about $650/ounce. Now there may be some opportunity for fast-handed speculators, but at the present price level I'm not that tempted, because I'm no Marc Faber.

UPDATE

iTulip quotes the FT to show that the rich are piling-in to physical gold, a Faber recommendation, presumably to preserve wealth - the analysis is that governments will enter into competitive currency depreciation.

Nice to have so much wealth left after buying all you need.

FTSE and Dow predictions revisited

The FTSE is standing (if that's the right word) at 4,732 (13:50 BST, 08:50 ET). It seems to be edging towards the region I guessed at on 26 June this year. It had closed the day before at 5,666.10 and I said this:

I suggested on Wednesday that the market may already have lost much of its bubble, considered in real terms, and here below is my simple attempt at chartism.

What I've done is to draw two purple lines, one connecting the lows in the mid-80s/early 90s, and the other the highs in the same period. I've chosen that time-frame because it's before the silliness of the late 90s, and it does also include a period when the UK economy was in the doldrums.

Using these parameters, the late 90s and early 00s were well above trend, whereas last year's highs only just peeped above the upper line and the current value is hovering a little above the centre of the hi-lo wedge.

The implications are that the next low, if it comes soon, shouldn't be worse than around 4,500, and by 2010 (when I'm guessing the tide will turn) the bracket would be in the 4,700 - 7,000 bracket, with a midpoint of c. 5,850.

Taking the market at close yesterday and extrapolating to that 5,850 midpoint, would imply a future return (ignoring dividends) over the next 16 months, of c. 2.5% p.a. - not nearly as good as cash, especially in an ISA. On the same assumptions, to achieve an ex-dividend return of 6% p.a. would require entry into the market at c. 5,400.

On this tentative line of reasoning, we should be looking for a re-entry opportunity somewhere in the 4,500 - 5,400 level, say 5,000. Shall we wait for the next shoe to drop?

How bearish are you? Too much so? See the poll in the sidebar.

By the way, I did a similar exercise for the Dow the next day and it suggested to me that the range should be 7,000 - 10,000.

UPDATE

I'm in good company:

Mr Lenhoff [chief strategist at Brewin Dolphin] predicted that the FTSE 100 could settle between 4,500 and 4,600: "In this bearish phase the market has given up more than 50pc of the bull market gain, we are back where we were in early 2004. One of the key retraceable levels is thought to be two-thirds of a bull-market gain, which would be between 4,500 and 4,600. The market looks like it wants to give up the gain."

Utter stupidity

A silly gloat here, about China being dragged down when the overspending stops.

When will the experts understand that Chindia will have the tools and skilled workers to rebuild their fortune, AFTER the Crash? Why on Earth has the East been subsidising the improvident West for so long, if not as part of a plan to extract all the means of production it could?

Do the experts not realize we have been in a state of economic warfare for years?

How to force the UK Government to give 100% guarantee on your deposits

... Transfer all your money to National Savings and Investments.

Their guarantee:

"Backed by HM Treasury
100% secure

National Savings and Investments is backed by HM Treasury, so any money you invest with us is 100% secure."

The Easy Access Savings Account can take up to £2 million per person. In all, depending on your age, NS&I could take more than £6 million per head.

If enough people know about this, and act on it, only Northern Rock will be run-proof. HMG will have to provide an "Irish guarantee". Unless, of course, the Chancellor suddenly welches on government credit, and that really would be the end; or closes the door to new NS&I deposits.

Total retail deposits in the UK are now around £1.17 trillion, of which nearly half is not covered even by the £50,000 deposit protection limit that came into force on October 3rd. So if everybody takes appropriate action, NS&I (and/or Northern Rock) should expect an influx of about £468 billion pounds.

Funds invested in NS&I stood at £84.8bn in 2007/08. A full-scale "flight to safety" would entail an abrupt 550% increase in their deposits.

Get in while you can?

But not into Ireland:


However, experts are already raising questions over the Irish scheme, and asking how much protection it really affords. Adrian Coles, the director general of the Building Societies Association, said savers should write to the Irish Embassy to ask them how they intended to guarantee UK savings, and how they would obtain enough sterling in the event of a bank failing.

"Has the Irish government quantified the potentially huge liabilities it is taking on by guaranteeing sterling deposits in Britain, where household cash savings amount to £1.1 trillion?" he said.

"Savers should beware that, if they switch accounts to take up this guarantee, they are effectively betting on the Irish government's ability to buy sufficient sterling in the foreign exchange markets.

The Chinese and US mortgage-backed securities

... and while we're discussing the potential in backing the horses that China bought into:

New York Times, 4 September 2008:

China’s central bank is in a bind.

It has been on a buying binge in the United States over the last seven years, snapping up roughly $1 trillion worth of Treasury bonds and mortgage-backed debt issued by Fannie Mae and Freddie Mac.

The $1.7 Billion Payday: How Bill Gross Made a Killing on the Bailout - Seeking Alpha (14 September 2008)

... The upshot is, Treasury Secretary Paulson was happy to make an example out of equity investors like Miller, who knew they were taking a big risk in pursuit of a big return.
But no way, no how was Paulson about to blow out the holdings of one of America’s top creditors (China).

By some estimates, China has now amassed as much as $1.6 trillion in foreign reserves, with more than two-thirds of that parked in U.S. debt instruments (agency debt, treasury bonds and so on). Burn those guys in a bailout plan? You’ve got to be kidding. Fiscally speaking, that would be like shooting ourselves in the foot with a machine gun.

So Gross had a pretty good lock on the situation. He knew it was sharp to align his interests with China’s. And to further ensure a positive outcome, the Bond King took every opportunity by ranting and raving from his soapbox -- a mighty big soap box -- about how government should be on the lookout for mortgage holders, and how letting mortgage owners suffer would be a travesty.

When news came out that the Fannie and Freddie debt holders would indeed be kept whole (as China demanded and Gross knew would happen), the value of those debt holdings soared, giving Gross a $1.7 billion pop in the value of his fund.

Business Week, 27 Sept 2008 (via Fox44 website)

"Perfect" Bond Asset Class?

Bill Larkin, portfolio manager for fixed income at Cabot Money Management in Salem, Mass., advises people to stay away from Fannie and Freddie debt except for shorter-dated maturities, since the agencies' fate remains to be seen. If they become part of the government, investors will win, whereas if they are broken into pieces, investors will lose because the debt will be much less liquid. He recommends other government agency debt such as that issued by the Federal Home Loan Bank or Ginnie Mae. He also suggests people buy these bonds to hold until maturity instead of buying them to trade them.

Aha!

I said in the previous post that I remembered some US official flying to China last year to flog mortgage-backed securities to them. Found it (13 July 2007) on Bloomberg:

... U.S. Department of Housing and Urban Development Secretary Alphonso Jackson is in Beijing to persuade the Chinese central bank to buy more securities from Ginnie Mae, a corporation under HUD that guarantees $417 billion in federally insured, fixed-rate mortgages.

... Ginnie Mae is ``in a better position than most'' to offer mortgage products because, unlike Fannie Mae and Freddie Mac, it provides the full backing of the U.S. government, Jackson said. Mortgage securities offer China's central bank better returns than U.S. Treasury bonds at the same level of credit risk, he said.

Now the chickens are flying back to roost.

Snap! And crackle...

On Thursday, I noted that, in the last 12 months, America has paid over $400 billion in interest payments on "the debt", AND increased the debt outstanding by around $1 trillion, making a total of $1.45 trillion. (I know I'm adding apples and oranges, but both elements are burdensome obligations.)

Now, noting the drop on the Dow and the cost of rider-bribes to the bailout bill, Karl Denninger is at the fruit-summing game:

Bailout Bill $700 billion
Additional Pork $150 billion
Dow (-484) in 3 hours $600 billion
Total carnage to you, The Taxpayer $1.45 trillion

The government is feeding the woodworms. Mish is convinced that deflation is inevitable ("There has never been hyperinflation in history with falling home prices.")

So you'd be forgiven for thinking, "What's the point in destroying even more money on this bonfire? Cut out and burn the rotten wood first, then rebuild the house."

Not so easy. The situation is especially bad because it's spilling over into international relations. Some American official (I forget who) flew over to China last year to get the Chinese to buy into mortgage-backed securities. Did the US really think a powerful partner would allow itself to be cheated when the package turned out to be rotten? (And didn't the Chinese know that, anyway? Isn't it possible they bought the rubbish because they were confident they could force the US Government to make good on it?)

I would almost say, buy into the packages the Chinese bought; but I expect there are ways to make the Chinese the preferred creditors and stiff everybody else.

Remember that Denninger has been saying recently, buy a good home safe and get your cash out of the bank? Let's see how unreasonable his doomster position turns out to be.